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"William F. Hummel" wrote:
> For most of the past 50 years, the Fed has targeted the interbank
> lending rate, not the money supply growth rate. There is even
> some question as to whether Volcker actually adopted the
> monetarist approach or simply proclaimed that he did in order to
> deflect the political pressure he would get if he openly raised
> short term interest rates.
To maintain a useful dialoque, one has to stay on the thread. You apparently did
not read carefully my previous post where I detailed the brief incursion by Volcker
into focusing on the money supply with his new operating method experiment. Or you
would not have made the statement above.
>
> >>
> >> (3) The cumulative total of Treasury securities in the Fed's
> >> portfolio is a function of the monetary base, most of which is in
> >> the form of currency. It is mainly the leakage of bank reserves
> >> into currency that forces the Fed to monetize the debt.
> >> Increased bank lending also forces it to do so.
> >
> >As I pointed out in my previous post, the number that the bond market and the
> >Fed watch is the M-1. The actual amount of the M-1 is less significant than
> >the change which foretells inflation or deflation rates in the near future.
> >
> M1 is virtually meaningless now and has been since the early
> 1990s when banks began the use of overnight sweeps to reduce the
> deposits subject to the reserve ratio requirement. I doubt that
> the Fed or the bond market pay much attention to M1 now. The
> total of banking system reserves reached a peak in Jan 1994 and
> has since dropped by 23% while M1 has remained nearly the same
> and M2 (a more meaningful measure) increased by 36%.
> >>
I was talking is the context of 1980 in my previous post. M-1 is less signifivcant
now because of the widespread efffect of structured finance. But there is neither
here or there.
> >> (4) When the Fed (actually the Congress) lowered the reserve
> >> ratio requirement in 1980, the Fed had to sell a substantial
> >> portion of its Treasury portfolio to the private sector in order
> >> to soak up the excess reserves that were created by the Act.
> >> Otherwise the Fed funds rate would have collapsed.
> >
> >This observation is tautologous. In my previous post, I tried to show that it
> >is not that simple. I will go into some detail here. I already mentioned that
> >the Monetary Control Act of 1980 was Congress' reaction to the Fed's push for
> >universal membership that it needed for political protection rather than
> >monetary policy control. The lowering of reserves was a concession made to
> >thebanks, both members and non-members, to win their support for the new >act.
> >Volcker and other Fed officials had fundamental concerns about financial
> >deregulation, both by institutional reflex and with real apprehension that the
> >elimination of government interest rate ceilings would weaken the Fed's own
> >control over the expansion of credit. But the political objective of universal
> >reserves outweighted the concerns of mechanical control. Volcker warned
> >Congress, rather disingenuously, that shrinking membership was atrophying the
> >Fed's "fulcrum for the conduct of monetary policy". As attrition causes the
> >total amount of reserves held at the Fed to decline, Volcker warned ominously,
> >the "multiplier" relationship between reserves and money increases tend to
> >become less stable. Consequently, fluctuations in the amount of reserves
> >supplied can cause magnified and unintended changes in the money supply. But
> >the same arguement applies to the lowering of reserves requirements which the
> >Fed had proposed. In both cases, the total amount of reserves fell. Yet Volcker
> >was silent on its mutiplying effect on reduced reserve requirements.
> >
> Mostly true, but my point above is valid and by no means
> tautological. The Fed lowered the reserve requirement again in
> 1992, from 12% to 10%. For an analysis of what happened, visit
> http://wfhummel.cnchost.com/moneymultiplier.html.
Again, I was talking about 1980s. The situation in the 90s was much different which
I have yet to post on. But I have visited you site and find you paper informative.
You wrote"
"While the Fed was giving with one hand, it was taking away with the other."
"The lesson here is that the textbook money multiplier has no real explanatory
power. It is merely an after-the-fact observation of the multiple. The required
reserve ratio as set by the Fed is only weakly correlated with the actual money
supply. The important point is that the money supply increases as a function of
demand. Demand in turn depends on many things, including the price of money as set
by the Fed."
Your observation is correct. Even in 1980, Volckers warning on the multiplier
relationship was not well grounded.
You then wrote:
"With the lowered reserve ratio and the further lowering of the FFR, to 3.25% in
July and 3.0% in October 1992, the Fed gave a very strong boost to the earnings of
banks, for which they can thank Dr. Greenspan."
The same was true in 1980 with the Monetary Control Act. But 1980, it was to
compensat to banks alleged losses due to hyper inflation which was non-existent,
rather than to boost US bank competitveness against foreign banks.
> >>
> >> (5) That lowered the interest income to the Fed. However the
> >> Fed typically rebates about 90% of its income. Thus the Fed has
> >> no need to increase its "revenue" by lowering the reserve ratio
> >> requirement. That is not a concern to the Fed.
> >>
> >You may have misspoken. The Fed decreases "revenue" when it lowers reserves
> >requirements. It is not accurate that this issue is of no concern to the Fed,
> >even though no question of Fed operating deficit was involved. But as the
> >bankers repeatedly complained, the Fed's merry-go-round cash flow with the
> >Treasury is actually using the banks funds to earn interest for the nation or
> >the people. Thus cutting down on reserve requirement is an anti-popuplist move
> >and the Fed was concerned politically with possible criticism. It introduces
> >fees to check clearing to cushion potential protest. The reserves reduction
> >amounted to a $5 billion tax rebate to the banks, and this was done at a time
> >when banks were charging 20% prime rates. The big banks got most of the
> >rebates while the small banks paid the freight. In 1980, 37% of US families had
> >no savings accounts. Another 29% had saving balances below $2,000. High
> >interest resulting from the 1980 Act cost them more in higer prices than they
> >received in added interest income. The elderly was in similar situation. One
> >truth about deregulation is that it tends to benefit large customers and
> >penalize small ones by shifting hidden subsidies to direct cost to customers.
>
> If reducing reserve requirements is an anti-populist move, then a
> lot of other nations are anti-populist. For example UK, Canada,
> Australia, and Sweden, do not impose reserve requirements.
The absence of reserves requirement itself is not necessarily anti-populist. But
once a reserve requirement is in place, the reduction of it is anti-populists, as
illustrated by the data I pointed out. The absence of an income tax is neither
populist nor anti-populists. But once an income tax regime is adopted, the
restructuring of it is can be either populist or anti-populist. It is self evident.
> The
> truth is that the customers of banks pay for banking services one
> way or another.
But not all customers pay the same amount, or need the same services. As an
economist, you must know that. There are big difference between an universal flat
rate and disaggregated user fees. But on a more fundsmental level, even users fees
are very problematic. I am sure your are familiar with all the arguments.
>
> >>
> >> (6) Since bank reserves earn no interest in the US, they are a
> >> drag on profits. The reason for lowering the required reserve
> >> ratio was to help US banks compete better with foreign banks,
> >> most of which have little or no reserve requirement.
> >>
> >In 1980, globalization of finance was not in full swing. Foreign banks were not
> >competing with US banks in any sustantial way. US banks were lending overseas,
> >but no too many foreign banks lent in the US, except in real-eatate. Besides,
> >those foreign banks that operated in the US are subject to the same reserve
> >requirements, and US bank subsidaiaries are not subject to Fed regulations.
> >Global competitiveness was seldem, if ever, mentioned in any of the
> >Congressional testimonies related to The Monetary Control Act of 1980.
> >Certainly, there was no race to the bottom argument in favor of lowering
> >reserves for US banks to compete with foreign banks. Governor Henry Wallich
> >was vocal about the Fed's ability to run the economy without any reserve
> >requirments, as some other central banks did. The discount window makes the
> >need for reserves redundant.
>
> Reserves are unnecessary and somewhat of an anachronism. If
> Congress agreed to eliminate the reserve ratio requirement, the
> Fed would have to remunerate those banks with settlement balances
> in the way other central banks do. Of course the discount rate
> would have to be somewhat above the remuneration rate.
>
> The only excuse for reserves in the US system I believe is that
> it does provide a buffer which helps to reduce the volatility of
> the interbank lending rate. This may be an important
> consideration due to the dollar's position as the world's primary
> reserve currency.
Again, the issue of reserve requirement are not that simplistic. Among other
things, the reserves regime is now almost a centruy old and carries with it social,
mental and behavioral imprints in the entire banking culture. It is like the income
tax. It is technically uneccesary as a revenue devise but it has taken on iconic
functions.
Henry C.K. Liu
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